Factors Affecting Foreign Direct Investments: Evidence from Sri Lanka

Abstract

This research highlights the critical significance of Foreign Direct Investments (FDIs) for Sri Lanka's economic development by examining the key factors influencing FDI inflows. The study employs the Autoregressive Distributed Lag (ARDL) model and the Chow test, utilizing annual data spanning from 1972 to 2018. Three baskets of independent variables are considered: macroeconomic factors (GDP growth rate, inflation, trade openness, and external debt), infrastructure (communication as a proxy), and qualitative indicators (political rights index).The analysis reveals that external debt negatively impacts short-term FDIs, while trade openness has a positive effect. In contrast, GDP growth rate and inflation prove insignificant in both short and long terms. Infrastructure, represented by communication, demonstrates a long-term positive influence on FDIs, while the political rights index exhibits a negative impact in the short run, displaying the highest level of significance at 1 percent. Furthermore, the Chow test confirms a significant impact on FDI inflows resulting from the civil war in Sri Lanka (1983– 2009). These findings suggest that Sri Lanka can enhance FDI levels by prioritizing trade openness, improving communication infrastructure, and addressing political rights issues. These factors play a crucial role in creating a favorable investment climate and promoting sustainable economic growth. Additionally, the study underscores the importance of political stability and security in attracting foreign investors, as evidenced by the influence of the civil war on FDI inflows.